Book Review: Dan Ariely, Predictably Irrational: The Hidden Forces That Shape Our Decisions (Revised and Expanded edition, Harper Collins, 2009)
Seldom does a non-fiction book by an MIT professor make the top five on the New York Times bestseller list. Neither is MIT, one of the world’s top scientific and engineering schools, noted for discarding logic and rationality. But Predictably Irrational achieved one and implied the other at its release in 2008 (the revised edition in 2009 looks at the recent banking crisis). The book, in the emergent field of “behavioral economics”, contains valuable insights into human psychology for the aspiring businessperson as well as the layman.
Here is an example: There are three subscription options for The Economist, i.e., web only for $59, print only for $125, and print and web for $125. Do you notice anything unusual about this price structure? Why would anyone purchase a print only subscription, when they could get a print and web subscription for the same amount?
The answer is that nobody does. The purpose of the print-only option is to serve as a “decoy,” in order to make the print and web version look more attractive. The author illustrates this in an experiment. With only two options, web and print + web, under one-third of subjects selected the more expensive print + web option (out of 100 business school students who had to purchase a subscription of some form). However, when the print-only option was added, suddenly over five-sixths of that population selected the more expensive print + web option and nobody selected the decoy choice.
This suggests, of course, that the decoy influenced more than half of the students. Yet according to conventional economics, individuals are perfectly rational actors. People spend money on what makes them happiest, and corporations seek to maximize profit.
We clearly do not seem to operate this way. Why do so many advertisements for cars feature classic rock or other music and images of driving through scenic vistas, but precious little information is given about fuel economy or mechanical reliability? Why does Coca-Cola spend over $2.7 billion per year advertising a drink that virtually everyone on the planet has tasted?
Dan Ariely catalogues ways in which people do not behave rationally, often conducting psychology-type experiments to pinpoint predictably irrational patterns. Perhaps his most interesting observation is that people have two modes of functioning: the economic mode and the social mode. In the social mode, we do not keep track of the value of every little thing, but are generous and figure that “what comes around goes around.” However, when money is brought into the equation, people snap into the economic mode. Indeed, an experiment is conducted in which people are either paid well or nothing at all, and tasks are performed equally quickly; when a small amount of money is given in payment, the completion of the tasks takes much longer.
This has surprising implications. If you are trying to put together a concert for a charitable cause, you are more likely to get successful musicians to play if you ask them to play for free (or perhaps you can cover their travel expenses) than if you offer them a small amount of money. If you need a business associate to make a phone call on your behalf, offering them something in return can damage your prospects. The placebo effect, where just the hint of a cure is perceived as helpful, and our preferences for free items over low cost ones, are other examples of predictably irrational reactions.
The book ends with Professor Ariely’s thoughts on the subprime mortgage crisis of 2008-9, and the federal rescue of large banks whose poor business decisions triggered and then exacerbated the crisis. We learn from experimental evidence that too high a salary can impede performance, that people generally do not accurately compute the maximum amount of money they should borrow, and that if we do not understand the rules of a system we are less likely to act in our own best interest. Professor Ariely ends with an analogy. Imagine if our roads were designed under the assumption that everyone was a perfectly rational driver. Lanes would be narrow, traffic lights would have no delay between red and green, and there would be no need for rumble strips or guard rails—our roads would really be far more dangerous than they are now. Conversely, our financial regulatory system is designed under the assumption that all actors are perfectly rational, when it is patently not the case.
Finally, a common fallacy is to assume that seeing right through a “decoy”, neutralizes its intended effect. What is true for an individual, however, may not be true for a collective. Indeed, in the study, nearly half the people’s choices were unchanged by the decoy. Of course, the key to successful marketing is not to convince everybody to buy a product, just to convince more people to buy it.
Predictably Irrational is strongly recommended to the aspiring businessmen, including independent musicians, who want to understand people and thus promote themselves and their products more effectively–as well as to anyone who wants the ability to spot when they are being manipulated, or wishes to see the world as it is, not how we wish it to be.
By Kevin Block-Schwenk
Kevin Block-Schwenk is an Assistant Professor in the Music Business/Management Department.